Does Government Always Have to Grow?
Historical knowledge brings perspective.
SEPTEMBER 01, 2002 by STEPHEN DAVIES
Filed Under : Government Spending, Taxation
One of the benefits of historical knowledge is that it brings perspective. Things that seem obvious look quite different when you realize that they are of recent origin. Things that seem inevitable do not appear so when you look at their past. One of the best examples of this is the size of modern government.
Today in the “developed” world, governments spend on average between 40 and 60 percent of the national income. Most people take this for granted. This is where the first element of historical perspective comes in. Government spending on this scale is historically recent. In 1900 the average share of national income taken by government was about 10 percent. Government spending rose as a proportion of national income throughout the twentieth century. The two critical episodes in most countries were the two world wars. Government spending soared during the conflicts. Afterward, although it declined, it never went back to its pre-war level.
All this is well known. There is an extensive scholarly literature on the reasons for this growth of government since 1900.1 The common conclusion is that the growth of government was unavoidable and is irreversible. However, taking a longer view than one that stops in 1900 leads to a different conclusion. Government grew, apparently inexorably, before and then was sharply cut back.
Modern public finance was invented in 1696, with the creation of the Bank of England. Before then rulers raised most of their income through direct loans from private bankers. This was a risky business as kings frequently found themselves unable to meet their obligations and resolved their difficulties by defaulting on their debts. The English government solved this problem by inventing the national debt, in which governments raise money by borrowing from the public through the issuing of bonds. The Bank of England had the responsibility of managing the government’s borrowing. However, as contemporary critics pointed out, the consequences were disastrous.
The invention of national debt enabled the governments of eighteenth-century Britain to spend money while putting the burden of paying for it on future generations. Until the 1820s most current spending was paid for by debt. The income from taxation was used primarily to service the debt. As a result, between 1702 and 1783 interest payments to debt holders accounted for 33 percent of government spending. Repeated wars and other spending led to a steady rise in both debt and taxes. By 1815 the level of taxation was 18 times what it had been in 1660. In 1660 government spending came to 3.4 percent of national income. By 1720 it had reached 10.8 percent, and by 1815 it had reached 19 percent. Given the nature of the economy at the time, the impact was as significant as the 40 percent of national income spent by governments today.2
All of this was sharply attacked by critics such as Thomas Paine. By 1781 the burden had reached an unsupportable level. The result was a program of “economical reform” launched by the new Prime Minister, William Pitt the Younger. This meant reducing the level of debt, abolishing many government posts and sinecures, and raising a larger proportion of current spending by taxation. With these measures Pitt was able to stabilize the public finances. However the level of national income taken by the government remained constant, despite Pitt’s efforts to reduce it. In 1791 war broke out with France and would continue with only a short intermission until 1815. As a result the rise of government spending began again and it reached its peak in 1815.
However the 1820s were a turning point. A series of budgets reduced the share of national income taken by government. This was taken even further in the central period of the nineteenth century. There were five elements to this policy: reduction of debt, which was used sparingly and mainly for long-term capital spending; financing of current spending through taxation and particularly income tax; steady and continuing reductions in indirect taxation; major reductions in government spending and stringent economy and control over what remained; and finally, stable money through the operation of the gold standard.
The result was that the nineteenth century was a mirror image of the eighteenth. The share of national income taken by government declined, and from the 1850s to the later 1880s was no more than 6-7 percent. Even in 1901, at the height of the Boer War, it was only 9 percent. Income tax peaked at 6.67 percent in 1855 (to pay for the Crimean War) and thereafter was stable at between 2 and 3 percent with a low point in 1876 of 0.83 percent. The cost of the Boer War and the naval arms race pushed it up to 6.25 percent in 1903, but it soon fell back, and by 1914 it was only 5.83 percent.3
Present Not Irreversible
All this puts the contemporary situation into perspective. Nobody should regard the present state of affairs as inevitable or irreversible. Clearly, there are many differences between the eighteenth or nineteenth century and today. However, there are also similarities. In both earlier centuries government spending was driven to high levels by a combination of elements in the political and social structures. Particularly important were the existence of relatively small but highly organized and politically influential groups that benefited from an expansive government and ways of financing state spending that obscured both its true cost and the distribution of costs and benefits.
In the eighteenth century spending rose despite vehement opposition. It then reached a natural limit, a point beyond which it proved politically and practically impossible to move. Something like this has also happened in the last part of the twentieth century. Government spending as a share of national income rose throughout the century but then hit a ceiling of between 40 to 55 percent, and has been unable to rise any further. In the nineteenth century Liberal politicians were able to reduce the size of government substantially and keep it small for a long time. The challenge facing those who would like to see a similar process today is different in some ways but fundamentally the same. Experience suggests that with the right combination of arguments and circumstances it can be done.
- See Thomas Borcherding, “The Causes Of Government Expenditure Growth: A Survey Of The U.S. Evidence,” Journal of Public Economics, 28 (1985), pp. 359-82, and Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (New York: Oxford University Press, 1987).
- Patrick K. O’Brien, “The Political Economy of British Taxation, 1660-1815,” Economic History Review, 2nd Series, 41 (1988), pp. 1-32.
- Allan Duncan and Dominic Hobson, Saturn’s Children: How the State Devours Liberty, Prosperity and Virtue (London: Politico’s, 1998), pp. 61-7